Saturday, April 29, 2017

Home Capital Group is an aggressive Canadian home lender that has hit a very rough patch. If you want a history Twitter will do it well. They have been fighting with Marc Cohodes (a very well known short seller) and you will find a timeline of the unfolding disaster by following Marc's tweets. [Disclosure: I have known Marc for 17 years and we are friendly.]

The crisis came this week when Home Capital Group entered into an emergency loan. The press release is here - but the salient points are repeated below.

TORONTO – April 27, 2017 – Home Capital Group Inc. (“The Company” TSX: HCG) today announced that its subsidiary, Home Trust, has secured a firm commitment for a $2 billion credit line from a major Canadian institutional investor.

The Company also announced it has retained RBC Capital Markets and BMO Capital Markets to advise on further financing and strategic options.

The $2 billion loan facility is secured against a portfolio of mortgages originated by
Home Trust.

Home Trust has agreed to paying a non-refundable commitment fee of $100 million and will make an initial draw of $1 billion. The interest rate on outstanding balances is 10 per cent, and the standby fee on undrawn funds is 2.5 per cent. The facility matures in 364 days, at the option of Home Trust.

The facility, combined with Home Trust’s current available liquidity, provides the Company with access to approximately $3.5 billion in total funding, exceeding the amount of outstanding High Interest Savings Account (HISA) balances.

Home Trust had liquid assets of $1.3 billion as at April 25, plus an additional portfolio of
available for sale securities totalling approximately $200 million.

Access to these funds is intended to mitigate the impact of a decline in Home Trust’s HISA deposit balances that has occurred over the past four weeks and that has accelerated since April 20. The Company will work closely with the lender to have the funds available as soon as possible.

This on the face of it is an extraordinary loan. It is secured by giving the collateral and costs something between 15 and 22.5 percent depending on how much is borrowed.

Its also extraordinary because of what it does not mention. It does not mention who the lender is and it does not delineate what the precise capital is.

But we know that this is being used to pay High Interest Savings Balances. We know there is a run on the bank here here and the run is several hundred million dollars per day.

This is desperation financing. They are securing mortgages (average interest rate below 5 percent) to borrow funds that cost 15 percent or more. The negative carry is huge. A financial institution cannot stay in business under these terms.

The stock reacted - dropping 60 percent in a day. The Canadian exchange busted some trades about $8.20 (because it thought that they were done in error). Mine were amongst the busted ones. I was perfectly happy to sell at that price however in their wisdom the exchange thought that mine was a fat-finger trade. [Disclosure - transaction to sell 30,000 shares at 8.19 was reversed.]

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Anyway the next day we found out who the lender was. It was the Healthcare of Ontario Pension Plan (HOOP). This was unusual because Jim Keohane was on the board of Home Capital and also the CEO of HOOP. Likewise Kevin Smith - Home Capital's Chairman - was on the board of HOOP.

The cries of conflict of interest were loud and undeniable.

The next day Keohane resigned from Home Capital's board and Smith resigned from HOOP's board.

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Then (Friday Canadian time) Jim Keohane gave the most extraordinary interview. You can find the whole thing here:

a). The loans are secured by 200 percent of their value in mortgages (which makes the investment almost riskless - and Mr Keohane goes to some lengths to describe how low the risk is), and

b). Me Keohane says the deal is more akin to a "DIP deal". DIP stands for debtor in possession and he is thus saying the deal is bankruptcy finance.

This is an extraordinary position for Mr Keohane to take. He was an insider to both institutions (a true conflict of interest).

What he is saying is that he isn't taking any risk because he has taken all the good collateral and he expects Home Capital go go bankrupt.

And note that he will make 15 to 22.5 percent return (more if the loan is repaid early in a liquidation) whilst taking no risk.

I have two words to say to this: fraudulent conveyance. In a rushed deal (one that truly surprised the market) done with undisclosed insiders up to four billion of the collateral and maybe three hundred million dollars of book value has been spirited away. And at basically no risk the recipient of all this largess.

Wow that was audacious. More audacious than just about anything I have ever seen on Wall Street.

Jim Keohane seems to recognise what he has said because almost immediately he says that he doesn't know what the acronym DIP stands for.

That surprised me: Mr Keohane uses the phrase DIP Financing precisely and accurately and in context and then says he doesn't know what it means. You should note that Mr Keohane is a very sophisticated fixed income player. (If you want a guide to how sophisticated read this...)

The position of the Canadian Government

The Canadian Regulator is put in an extreme bind. Up to $300 million of value has been spirited away from a highly distressed institution.

The regulator however has guaranteed a very large amount of funding of Home Capital (guaranteed deposits). They should be alarmed at up to $4 billion in collateral being spirited away to HOOP. This effectively subordinates the insured depositors and in the event of Home Capital's failure will cost the taxpayer several hundred million dollars.

This is not an idle concern. The funding itself indicates that it is very likely Home Capital will collapse. And a former director described this as akin to DIP Financing.

If I were the regulator

If I were the regulator I would be doing my duty here. My duty here is to protect the taxpayer.

Very rapidly Home Capital needs to find a buyer to assume the government insured obligations. It does not matter if this happens at 20c per share. Indeed from a regulatory perspective it is better if it happens at a low share price because it gets rid of claims of bailouts inducing moral hazard.

If Home Capital cannot find a buyer then it should be liquidated. Immediately. And the transaction with HOOP should be reversed under standard bankruptcy rules for reversing fraudulent conveyance. There is no reason that taxpayers should accept subordination to a loan yielding 15-20 percent.

Indeed regulators have a duty to stop that sort of thing.

John

Disclosure: I am short a modest amount of Home Capital stock so I have a vested interest in its collapse. Canadian taxpayers are on the hook for billions in guarantees. They have a bigger vested interest. Either way this one is toast. But a special sort of toast which allows HOOP to keep all the cream and jam spread.

Also note: this is the first Australian or Canadian mortgage lender to near collapse. That is an important step in the end of the property bubble.

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It is also worth noting that Wikipedia give a standard list of indicators that fraudulent conveyance has taken place. Most appear to be triggered here.

Becoming insolvent because of the transfer;

Lack or inadequacy of consideration;

Family, or insider relationship among parties;

The retention of possession, benefits or use of property in question;

The existence of the threat of litigation;

The financial situation of the debtor at the time of transfer or after transfer;

The existence or a cumulative effect of a series of transactions after the onset of debtor’s financial difficulties;

Monday, April 24, 2017

In New South Wales we have just had a moral-conservative Premier who enacted late-night alcohol bans in large parts of Sydney justified from a moral panic about alcohol fuelled violence. This has destroyed much of Sydney's nightlife.

I can imagine Anthony Bourdain doing a show on Sydney. It would be embarrassing. This city has become dull.

The departed Premier also banned greyhound racing - which in Australia is a sort-of-poor-man's-horse racing. The dogs are a working class pursuit - sometimes involving cruelty to our canine friends (but probably not much worse than the cruelty to horses racing them). Electoral politics forced the Premier to reverse that ban.

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Since then the New South Wales Premier has changed - and so I saw my chance to write a letter to my local politician.

I have not received a response from him - so I am putting the letter here for wider circulation.

Dear Rob Stokes
Member for Pittwater,

I am a member of your electorate. Address ***.

I want to make sure that under Gladys Berejiklian the New South Wales Government continues its attempt to morally regulate everything enjoyable in human society. This was the tradition established by our departed and sorely missed honourable spoilsport and former Premier.

You have banned drinking in large parts of Sydney. I applaud you. People should not be allowed to have a good time.

But you chickened out and reversed your entirely admirable ban on greyhound racing.

I am deeply alarmed.

Worse: I have come across the new trend of corgi racing.

Here is a corgi race - the Ladbrokes Barkingham Palace Gold Cup.

It looks like a lot of fun - and thus should be banned.

Corgis are blessed creatures, dour hunting dogs suitable for keeping Her Majesty, Queen of Australia, company. But use of them to have a good time is abuse of the finest traditions. And an insult to our Queen and hence our system of Government.

I want to make sure that you recommit to banning dog racing in New South Wales, and of the utmost importance you should commit to banning corgi racing.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.